Three Cheers for Cheap Oil

By

Thomas G. Donlan

Jan. 10, 2015 1:19 a.m. ET

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As J.P. Morgan Sr. said about the stock market, the one thing that we know about the market for oil is that it will fluctuate. What we also should understand is that the fluctuations are unpredictable.

Energy prices around the world are in the tank again. The price of oil sank below $50 a barrel last week, continuing a collapse that started six months ago, when it was about $115 a barrel.

The recent decline has been described as astonishing, but only by people who have forgotten the $145 peak in mid-2008 and the trough of $32 a barrel near the end of that year.

How low can oil go now? Natural-gas prices, which started busting earlier, have bounced back to about $4 per thousand cubic feet. To match that price on an energy-equivalent basis, oil would have to sell for about $23 a barrel. Gas is a premium fuel, however, and it’s easier to extract gas from shale than it is to produce oil from similar strata. So, it commands a somewhat higher price per unit of energy.

One Thing After Another

The history of fossil-fuel development shows the same pattern over and over again, yet producers and consumers are always surprised by the sudden changes. It’s as if the hand of the market really were invisible.

Every time, the pattern is there for all who wish to see it: High prices for raw energy prompt the discovery of new territories and new production technologies. Then much new oil and gas can be produced, so every boom is followed by a bust, followed by another boom, and so on.

It doesn’t matter if the new supplies are added with heavy investment. It doesn’t matter if the investment funds were borrowed. It doesn’t matter if the oil must be sold at a loss. Once the investments have become wells, those costs are sunk. The owners of the new wells have to produce for any price they can get that’s better for them than the cost of liquidation.

Although some people who root for an energy disaster were predicting that oil would hit $300 per barrel in 2013, most people who have lived through more than one energy cycle knew there would be a bust. They just didn’t expect this one to arrive so soon. And now most people understand that there will be a shakeout, an investment bust, and higher consumption of cheap energy supplies, which will produce higher prices, sooner or later.

A look at any day’s financial pages indicates that most experts think the rebound will come quickly because current low prices are just crazy—and because the experts have a lot invested in high prices, so they have a lot to lose. But as John Maynard Keynes learned from his currency speculations in the 1920s: “The market can stay irrational longer than you can stay solvent.”

Powers of Prediction

When someone tells you that the price of oil will be back above $100 a barrel by the end of the year, just nod wisely and say nothing. Don’t get in an argument, because they don’t really know, and neither do you.

The next shortage and the next price boom may arrive next week, but the cycle could run 10 years this time. The U.S. is still in the early stages of exploiting its fracking technology. Some states and many other countries are still deciding whether to use it at all. New York Gov. Andrew Cuomo actually turned his back on tapping natural-gas resources upstate, and Californians are still fighting about their shale oil.

Tar-sands oil from Canada is still looking for cheap transportation to welcoming markets. If Mexico follows through on its recent decision to free its energy resources for private and foreign-backed development, North American production will grow more dramatically.

To affect world energy prices, North America doesn’t even have to export very much fossil fuel in the coming decade. Just reducing the U.S.’s long dependency on imports will free up oil and gas from the traditional exporting countries and the ones coming on line, eager to cash in. There might even come a point when Saudi Arabia’s production policies can’t move the market anymore.

Some European countries that have been using high-cost energy are prime prospects for exploiting their own opportunities to produce natural gas, and maybe oil, with fracking. Poland, Ukraine, Germany, and the United Kingdom clearly can become important gas and oil producers, if they adopt policies favoring production.

Farther away, in the Levant, there are gas and oil opportunities using the new technology in Jordan, Israel, and offshore in the eastern Mediterranean Sea between Israel and Cyprus. (Israel may be a tiny country, but it seems to have as much frackable shale oil as Saudi Arabia has conventional oil. It also has an unenviably large supply of environmentalists opposed to fracking.)

Geology is on the side of production: Frackable shale deposits are often associated with coal deposits. The world’s 10 largest coal producers are China, the U.S., India, Indonesia, Australia, Russia, South Africa, Germany, Poland, and Kazakhstan, suggesting that at least some of them will also become fracking giants, if not in this oil-price cycle, then in the next one.

Universal Tax Cut

The most satisfying result of collapsing energy prices will be the economic growth that takes place because cheapening energy is like cutting taxes. It encourages consumption of everything and production of everything that uses energy. The second-most satisfying result will be the damage done to OPEC and all the oil-controlling dictators, sheiks, and presidents for life—and to their foreign bank accounts. The third most-satisfying result will be the embarrassment of the “running on empty” crowd and the nullification of their theories about imminent “peak oil.”

Such satisfaction must be paid for by someone: The losers must include suppliers of fracking sand and other oilfield equipment, investors in undercapitalized drillers, developers of oil fields in deep-ocean waters and the governments that feed on them.

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